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Legal Pitfalls in Blockchain Smart Contracts to Avoid

Legal pitfalls in blockchain smart contracts can lose you a lot of money—but they are avoidable if you know what to do.

Bitcoin is in the news, no matter where you look. Everyone wants to get a slice of the blockchain pie. Investing in Bitcoin and other cryptocurrencies is trendy, but what happens once you actually buy the cryptocurrency and try to use it?

If you spend at least one weekend trading Bitcoin, you already will know. Well in most cases, you will end up in a smart contract—and those can actually cause a lot of headaches. In some cases, it can reverse a transaction you made or cause some disputes to arise.

That's why we're offering a step-by-step guide on how to avoid the legal pitfalls in blockchain smart contracts, and get the most out of your transaction.

Before you can understand the legal pitfalls in blockchain smart contracts, you need to understand what a smart contract is.

Blockchain transactions area all done with a smart contract code. This is code that is stored in the blockchain's ledger, and automatically performs every party's duty in an "if-then" situation. This eliminates the need for a neutral third party, and also makes sure that everything is confirmed on both ends.

Seems easy, right? Well, usually, it is. Smart contracts can be written out and have clauses that can help bolster them.

However, it starts to make you ask a couple of questions about the nature of cryptocurrency transactions. Would courts consider a computer ledger to be a legally binding agreement? What happens if a dispute arises that the computer doesn't pick up?

These legal pitfalls in blockchain smart contracts seem negligible, but it can cause a lot of money if you end up in the wrong situation. Knowing this, it's easy to parse out the potential problems and prevent them.

Problem 1: There's a good chance it's not legally binding.

Just because it's a smart contract doesn't make it legally binding. In fact, there's not really a legit contract, per se. BitcoinMarketInsider explained it this way:

"With a smart contract, but the parties are not necessarily making and accepting offers — they’re agreeing to some mutually agreeable computer program that outlines the if-then conditions concerning the trade between the parties. In the view of a courtroom, this by itself might not produce a binding agreement. If the agreement isn’t binding, it could be challenging to recover damages down the road."

In other words, it's probably not a legally binding code in many areas. However, there are ways to ensure that your transaction is as fair as can be, as specified below.

Solution 1: Use clauses written into the smart contract to limit it—or have it in writing elsewhere.

Writing is the key to ensuring that you get your fair share, should you end up having a dispute. The best way to do this is to have a smart contract clause that explains what the transaction is for and what the terms of the transactions are.

The fact is that people who want to have major transactions with cryptocurrency should consider having a separate contract in writing in order to ensure they actually can go to court.

Problem 2: The jurisdiction isn't always defined, which means going to court can be difficult if not impossible.

Cryptocurrency transactions happen on the internet—and they happen around the world while people are sitting on their chairs in different countries. For the most part, this is okay.

However, once in a while, there may end up being a moment where a deal falls through and someone walks away with cash that's not earned despite smart contracts being in place.

For example, if a person who buys something in Japan finds out that the Brazilian seller decides to renege on the deal after convincing him to clear the contract, where would they go to court? Would it be Brazil, or Japan?

When you're doing deals on the net, it's hard to actually come up with a jurisdiction to settle things out in court. This means that one of the biggest legal pitfalls in blockchain smart contracts is the issue of location and law.

Problem 2, continued: Not all countries have laws in place about international trade disputes involving cryptocurrency, and if they do, it's hard to enforce them.

Have you ever been stiffed on a purchase you made online, with a person from a foreign country? In most cases, PayPal or credit cards will refund you the money for a trade gone wrong, but with cryptocurrency, this isn't always the case.

In certain rare cases, smart contracts will not see the dispute that happened. And, the transaction would go through—which means that someone might end up losing a lot of money as a result of it all.

Since the currency will not work out the dispute, you may have to go to... who? Police will normally not touch this issue, and may refer you to another agency. The other agency may not know how to deal with it, and will refer you to police.

These kinds of trades, sans smart contract, are difficult to enforce. So, it quickly becomes one of the worst legal pitfalls in blockchain smart contracts.

Solution 2: Designate a jurisdiction, and trade personal contact information in the event of a dispute.

The easiest way to make a smart contract work for you is to designate a specific city and country's jurisdiction to resolve any disputes you may have in court. This way, it leaves no grey area.

To ensure you have everything you need to actually go to court, include your information and theirs in the smart contract—along with a way to confirm it.

Problem 3: There's usually no clear resolution mechanism in place.

If both parties agree to it, having a dispute resolution mechanism can help clear things up. One of the legal pitfalls in blockchain smart contracts, though, is that most people run away the minute they hear "mediation" or "arbitration."

This leads them to run away from the clause—or just not include it at all.

So, generally speaking, if something happens as far as conflicts go, there's no agreed-upon way to resolve it. This often will lead to courts, online bickering, and other similar loss.

Solution 3: Add an agreed-upon conflict resolution clause into place in the smart contract.

Once again, the key to making sure that the smart contract is as useful as possible is communication. Even if it's standardized to something as simple as asking for a designated mediator, your smart contract can be a lifesaver.

Problem 4: The transaction may not even be legal in area, at all, and going to court could lead to punishment for both parties.

Though a lot of people will sidestep the glaring issue in the room, it doesn't make sense to talk about the legal pitfalls in blockchain smart contracts without acknowledging it. Blockchain currencies are not always used for legal transactions—particularly on the Dark Web, or on sites like Silk Road.

There is a reason why Bitcoin is a criminal currency to many cyber-investigators. It's used in a lot of very illegal transactions. If your transaction falls through or gets picked up by authorities, you will probably be in a world of trouble.

If you're trading illegal things, or working with sketchy people, all the advice on how to avoid legal pitfalls in blockchain smart contracts will be useless to you. Use common sense, and don't do things that can end up causing you so much trouble.

At the end of the day, there's only so much that blockchain currency can offer you in terms of security.

The best advice we can offer in terms of avoiding legal pitfalls in blockchain smart contracts is to use common sense, communicate, and also think before you click. If you don't feel you can trust the transaction, it may just be better to use cash instead.